Fitch Rates Dallas ISD, TX $400MM GOs 'AA-' Und.; Downgrades Outstanding Debt

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned its 'AA-' underlying rating to Dallas Independent School District, Texas' (DISD, or the district) $400 million unlimited tax school building bonds, series 2008. The district has applied for and expects to receive the guarantee from the Texas Permanent School Fund, whose Insurer Financial Strength is rated 'AAA' by Fitch. Additionally, Fitch downgrades the underlying rating for the district's $1.4 billion unlimited tax school building bonds outstanding to 'AA-' from 'AA'. The bonds are scheduled to sell via negotiation the week of Dec. 1. The Rating Outlook is revised to Negative from Stable.

The bonds are payable from an unlimited ad valorem tax levied against all taxable property within the district. Proceeds will be used to finance the acquisition, construction and equipping of school buildings and to pay issuance costs.

Fitch takes this action in response to a weakening financial profile at the district, as well as recent exposure of systemic problems regarding financial controls and oversight. The announcement earlier this year of an unexpected sizeable operating deficit for fiscal 2008 has sharply reduced reserve levels and brought into question budgetary and financial management practices at DISD. The Negative Rating Outlook reflects Fitch's concern about further erosion of reserves and remaining challenges regarding the implementation of necessary internal controls and communication procedures. Positive credit factors for the district include a moderate debt profile and a local and regional economy that are performing relatively well during the current recession.

District officials initially projected a general fund deficit for fiscal 2008 in April, but expected at that time that state funding would minimize the impact to reserves. District auditors and staff confirmed a sizeable deficit in September, and the current projection is for a $57 million shortfall. This amount will effectively shrink district general fund reserves by one-half; the fiscal 2007 total general fund balance was $120.1 million, and the unreserved balance was $105.8 million. District staff attributed the deficit to poor controls and inadequate communication between various district administrative departments, as the hiring of an estimated 750 teachers during the current fiscal year was not factored into the fiscal 2008 budget. The late release of the district's fiscal 2007 audit, in which external auditors identified a number of weaknesses and deficiencies regarding internal controls, accounting procedures and financial oversight, further magnified the scope of the district's problems.

Budget concerns have continued into the current fiscal year, as administrators attempt to close an estimated deficit for fiscal 2009 of more than $80 million through staff reductions and other spending cutbacks. The district declared a state of financial emergency in September, which allowed it to lay off teachers presently under contract. The total number of employees terminated to date is 1,000, including approximately 700 teachers. District staff estimates the payroll savings from the layoffs will total roughly $26 million for fiscal 2009 and more than $50 million for fiscal 2010. Despite these and other measures, the district still faces an estimated $25 million to $30 million operating deficit for fiscal 2009. Officials report that efforts are underway to generate additional savings that are expected to close the remaining budget gap. A revised fiscal 2009 budget is expected to be presented to the district board early next month.

Not surprisingly, staffing changes have accompanied the deteriorating financial position of the district. The former chief financial officer and budget director have been terminated, and the district has hired a new executive director of financial services. The fate of the district superintendent also is unclear, as several district board members have recently called for a no-confidence vote. District staff has developed a corrective action plan, which is envisioned to restore internal controls and procedures over a 3-year period at a cost of at least $10 million. Staff also plans to prepare a financial recovery plan to restore operating reserves over the same timeframe; the details of this plan are expected once the fiscal 2009 budget revision is completed. Fitch believes the district's current financial condition is not consistent with the 'AA' rating category, and believes that further rating action is likely unless improvement in both financial management and reserves occurs.

The current offering is the first installment of a $1.35 billion bond authorization approved by 54% of district voters in May 2008. The current capital program includes funding for new and replacement schools, renovations and additions at existing campuses, and a variety of other improvements. This program, which is projected to meet district capital needs through 2014, is expected to have a debt service tax rate impact of roughly $0.06 per $100 of taxable assessed valuation (TAV). Although increasing with recent borrowings, Fitch considers the district's direct debt burden still moderate. The pace of debt retirement has slowed considerably also as a result of recent offerings, and now is well below average.

TAV growth rebounded over the past four fiscal years after slowing appreciably from fiscal 2003-2005. The fiscal 2009 TAV of $79.7 billion represented a solid 9.3% increase from last year. These gains reflect the recent expansion of the local and regional economies, which included healthy residential and commercial development activity. Although the pace of housing starts has slowed noticeably in recent months, the most recent residential foreclosure and delinquency rates for the Dallas-Fort Worth metropolitan area are below national averages.

The district is the second largest in the state, with an estimated 158,000 students. Enrollment, which has declined marginally over the past several fiscal years, is projected to stabilize around current levels. The district serves the majority of the City of Dallas, as well as all or portions of 11 area cities and towns, with a total estimated population of approximately 1.3 million. District facilities currently include 157 elementary schools, 31 middle schools, 23 high schools, and several magnet and alternative campuses. District staffing presently totals 21,000.

Fitch issued an exposure draft on July 31, 2008 proposing a recalibration of tax-supported and water/sewer revenue bond ratings which, if adopted, may result in an upward revision of this rating (see Fitch research 'Exposure Draft: Reassessment of the Municipal Ratings Framework'.) At this time, Fitch is deferring its final determination on municipal recalibration. Fitch will continue to monitor market and credit conditions, and plans to revisit the recalibration in the first quarter of 2009.

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